MSN - Why gas prices will soar again

http://articles.moneycentral.msn.com/Investing/MutualFunds/why-gas-prices-will-soar-again.aspx?page=2

Remember how outraged we were when oil soared and oil companies posted record profits? It will happen again. Cash in on it this time around.

If your wallet is feeling fatter with gas prices stuck around $2 a gallon, here's a little tip:

Take some of the money you're saving and shove it into oil investments.

To the long list of stock sectors huddling in the market's cold bargain basement, add the oil patch. Prices of petroleum and natural gas have plunged from nearly twice what most observers regard as reasonable to nearly half.

Energy stocks have fallen right along with them. And though some have started to rebound, they're still well below the levels they hit when gas was $4 a gallon.

It's pretty much a sure bet that fuel prices will rise again and that energy companies will cash in again. Oil has fallen from more than $147 a barrel to below $41 today, and few, if any, analysts think that will last long term.

"The secular bull market (in energy) is intact," says Tim Guinness, the lead manager of the Guinness Atkinson Global Energy Fund (GAGEX). "There will be a breathing space over the next three years . . . where oil trades between $60 and $80. It's not going over $100 for three years, at least, but go above $100 it will."

You'll recall that oil companies posted record profits when gas prices were soaring. Consumers and politicians were outraged, but nothing changed. It will happen again, and you and I might as well get a piece of the action.


No end to demand

One reason energy prices will rise is that the ambitious plans of President Barack Obama and other world leaders to develop alternatives to fossil fuels will take decades to have an effect.

Meanwhile, consumers of energy are proving more sensitive to price than to the recession. Oil consumption has been declining, but the pace of the decline has slowed as prices have come down. MasterCard reports that year-over-year declines in gasoline purchases sank 3% in December, down sharply from a drop of 7.6% two months earlier. The International Energy Agency forecasts that global consumption, which declined in 2008 for the first time since 1983, will grow by a half-million barrels a day this year, though many independent analysts believe this estimate is too high.

Advocates of alternative sources of energy, meanwhile, acknowledge theirs will be a lengthy quest. If the United States reaches the goal of having 1 million plug-in hybrid cars on the road by 2013, they will still account for only 0.4% of the total number of cars. Wind farms and, especially, solar power for electricity generation could garner a greater market share than that, but it will still be measured in low percentages for at least a generation.

And China's policies in coming years could put as many as 600 million more cars on the roads -- 20 times as many as the country has now and more than twice as many cars as are on U.S. roads today.

That all adds up to a huge increase in demand for limited supply. And makes higher energy prices one of the safer bets in the market today.

The perfect vehicle for this ride is a broad-based energy or natural-resources mutual fund, such as such as Vanguard Energy (VGENX), or a similar exchange-traded fund. Pockets of the energy group, notably exploration, production and oil-field services, are likely to lag the commodity as integrated oil giants slash expenses to ride out the recession. But the major oil companies will outperform the commodity in the end because they reap outsize profits from marginal increases in price.

A troublesome market

Of course, fossil fuels are a messy business. Control resides only partly in the free market. Much of the production comes from the Organization of Petroleum Exporting Countries, a price-fixing organization that would be illegal in the developed world -- but OPEC nations are largely undeveloped and ruled by quixotic dictators.

OPEC is also far from homogeneous. At least two of its members, Iran and Venezuela, are fiercely anti-Western. Venezuela, Mexico and, to a growing extent, Russia are so mismanaged that oil production was falling even as the price was peaking last summer.

So, though OPEC has an announced goal of cutting production by 2.5 million barrels a day, to bring supplies closer to demand and again raise the price, the market doesn't care. The spot price fell more than 25% in the two weeks after this decision was announced in mid-December.

Further overhanging the energy marketplace is the forward trading of speculators, both those inside the industry, such as oil companies, and outsiders, referred to as noncommercial interests. Noncommercial open contracts on the Nymex soared to 65,000 at the end of December from 2,000 at the beginning of the month.

Fund manager Guinness, who is based in London, notes that this level of interest among traders rivals the most recent high, reached last March. "When these long positions unwind, they can put significant downward pressure on the spot price," he says.

What that means to most investors is that oil prices -- and stocks that are basically pegged to them -- can be full of surprises. But since markets are forward-looking, so many of them are already anticipated and written into the stock prices that they don't matter.

Oil and stocks underpriced

That means that worries about consumption, Obama and OPEC are reflected in the current prices for both oil and the companies married to it. The price range Guinness expects for oil -- around $75 a barrel -- would represent a near doubling of the current price, which closed at $40.08 on Feb. 2.

Oil analysts were forecasting exactly this price in November 2007, when oil was trading above $90 and I wrote a column titled "Cash in your oil profits now."
Since it was published, one of the purest plays in the sector, Energy Select Sector SPDR (XLE, news, msgs), had tumbled 35.8%, as of the Jan. 28 close.

By way of comparison, the natural-resources ETF that I own and recommend, iShares S&P North American Natural Resources Index (IGE), had plunged 42.5% in the same period, principally because it diversifies about 15% of its assets into other natural resources, including metals and timber. They've been whacked even harder than oil.

(Both ETFs, and most resources mutual funds, pack their largest allocation of assets in the integrated majors such as Exxon Mobil (XOM, news, msgs), Chevron (CVX, news, msgs) and ConocoPhillips (COP, news, msgs).)

For the benefits of diversification, the iShares ETF is the resources investment I would recommend going forward. Non-energy natural resources are more sensitive to recession than oil; that's why they're down more. But what lies ahead of us right now is recovery from recession. So while both members of the team should outperform the market over the next 18 months, this minority member should slightly outperform its companion.

Similarly, I own a broadly diversified natural-resources mutual fund, T. Rowe Price New Era (PRNEX), rather than an energy-only fund.

"New Era" in this fund's name has significance now. Launched in 1969, the new era of those years was a regime of rising and ultimately crippling inflation. Resources such as oil, gold and timber have built-in inflation protection. And we're going to need it. Congress is larding the so-called economic stimulus package with so many permanent spending increases, and so few corresponding tax increases to pay for them, that the federal deficit is expected to top 100% of gross domestic product within two years.

That would put us on a par as a debtor nation with Italy, which surrendered world leadership nearly 2,000 years ago. Today's Italy, bound to the euro, cannot inflate its way out of recession. The United States can and will.

Recovery runs on oil

The global economy will recover, probably beginning in the second half of this year. Energy will literally fuel this recovery and nowhere more so than in the rapidly developing nations of Asia, notably China. The great bulk of their populations have not yet benefited from globalization, but the benefits have rained down so close that they are keenly aware of them, envy them bitterly and are beginning to demand a share of them aggressively. Political leaders who don't deliver won't survive.

Portfolios light on resources like oil and gas won't deliver either. Recoveries need fuel. In the words of an old Exxon slogan, put a tiger in your tank.